Going green

Trading credits: Richard Sandor's firm is setting up the Chicago Climate Exchange, the first exchange for trading in carbon dioxide emissions. The former Chicago Board of Trade economist helped create a similar sulfur dioxide exchange in the 1990s. Photo: Steve Leonard

As the chief economist for the Chicago Board of Trade in the 1970s, Richard Sandor is widely regarded as the intellectual father of the financial futures market that transformed the board from a primarily agricultural commodities exchange to a far more diversified one.

As a result of that innovation  and for his subsequent work as the manager of traders in interest rate futures and derivatives  Mr. Sandor is a very wealthy man. He also made it possible for countless other traders to make their fortunes in a market that now trades about $14 trillion in contracts annually.

As a byproduct, economic experts say that the exchange he fostered has stabilized interest rates in the last two decades, contributing significantly to the availability of home mortgages that in turn spurred a residential building boom and the possibility of home ownership for a larger segment of society.

But now, Mr. Sandor is looking to make a social benefit the raison d'être, rather than the convenient consequence, of a new market.

As CEO of Environmental Financial Products LLC, Mr. Sandor is creating the world's first exchange for trading in carbon dioxide emissions. The idea is that, by providing an economic incentive for entities that emit CO2 and other greenhouse gases to cut back on those emissions, the market can be part of the solution to global warming, one of the most serious threats to the planet.

"What sparked me was the realization that markets could be used to address environmental and other social problems," says Mr. Sandor, 59. "I come at this more as an economist with a concern for the environment than as an environmental activist."

Pointing to a market he helped develop in the early 1990s to trade sulfur dioxide (SO2) emissions, Mr. Sandor says the same model that has dramatically reduced industrial pollution of that acid-rain-causing chemical can be used to spur cuts in greenhouse gas emissions.

While early estimates pinned the cost of cutting sulfur at up to $1,600 a ton, SO2 futures actually trade at closer to $160 a ton in the $3-billion-a-year trading market. That's because polluters provided with a new market incentive cut emissions far less expensively  and at a much faster rate  than anyone predicted when trading began eight years ago.

But even supporters say the Chicago Climate Exchange, Mr. Sandor's carbon trading scheme, faces challenges the SO2 exchange never did. That system was mandated as part of the Clean Air Act amendments of 1992, which set reduction targets that the relatively small number of SO2 polluters  mostly large coal-burning utilities  would have to meet by 2003.

This system's voluntary

In contrast, the number of carbon polluters is far greater: virtually any entity that burns fuel. In addition, because forests, oceans and certain types of soil can be used to draw CO2 out of the atmosphere, the new exchange envisions a role for activity that offsets CO2 pollution through reforestation, no-till farming and other efforts.

But the science supporting the value of these methods is far from clear, which will make a fair and impartial trading system harder to design.

However, the biggest difference between the two exchanges is the voluntary nature of the CO2 trading system. The exchange now being designed with the help of about 25 corporate and agricultural participants, funded by a $347,000 grant from Chicago's Joyce Foundation, hopes to begin trading by yearend in seven Midwestern states on a totally voluntary basis. The ultimate goal is to expand the system to the rest of the U.S. by 2003, and internationally by 2004.

While Mr. Sandor says that the participating companies  which include BP Amoco of North America, Ford Motor Co., DuPont Co. and International Paper Co.  have many incentives to participate, the decision to build a voluntary system may be as much political as economic. As a presidential candidate, George W. Bush supported the Kyoto accord  an international treaty to set targets for greenhouse gas emissions  but President Bush backed away from Kyoto earlier this year. Without his support, the chance of mandating a carbon emissions trading system is slim.

Inducements to participate

Unless targets are mandated and government is involved in monitoring and verifying those reductions, economists and environmentalists familiar with the Chicago Climate Exchange say it faces a serious challenge.

"We need the government to mandate cuts. Otherwise, there is no level playing field, and the laggards who don't participate are rewarded," says Fred Krupp, executive director of Environmental Defense, a New York-based environmental advocacy group.

Jon Goldstein, a resource economist for the U.S. Department of the Interior who has known Mr. Sandor since they attended graduate school together at the University of Minnesota in the 1960s, also sees problems with a voluntary model.

"I make my living from market failures. That is what degradation of the environment is about," he says. "Without a collective will, individuals just do not have the incentive not to emit these gases. The costs are too high and the benefits are small."

But Mr. Sandor and others do see inducements for voluntary participation. "Many of these companies operate internationally, and they see caps coming in other jurisdictions," Mr. Sandor says. Denmark already requires companies doing business there to reduce greenhouse gas emissions, and Great Britain and the Netherlands will soon have caps in place.

Don Coursey, a professor of public policy at the University of Chicago, adds that companies may see a marketing advantage to being a good corporate citizen.

"And they may also realize that by participating in a voluntary system, they could prevent a more cumbersome and inefficient regulatory approach," he says.

Those at the companies helping to design the trading system see other benefits as well.

"By being involved in designing this system, we are well-positioned if a trading mechanism is widely implemented down the road," says Martin Zimmerman, vice-president of government affairs at Ford, based in Dearborn, Mich. "And by being involved at this stage, we can help to establish the rules and mechanisms for the process, which positions the company very well."

Straddling two worlds

While none of the companies that signed on to designing the Chicago Climate Exchange have agreed to participate in trading, their involvement in building a system that would compel them to make 2% reductions in the first year and 1% annual reductions thereafter is unique. Those involved say it is testimony to Mr. Sandor's skills.

"Rich is one of the few members of our industry capable of original thought, so his ideas always get the measure of respect they deserve," says Leslie Rosenthal, a former Chicago Board of Trade chairman and a member of the Chicago Climate Exchange's advisory panel. "He is also that rare breed of academic who can actually put his ideas into practice, pushing things further and into higher echelons of power than the average economist."

To achieve his ends, Mr. Sandor is also able to straddle two dissimilar worlds: the greed-is-good embrace of capitalism that is futures trading and the stereotypically more left-leaning milieu of environmental activism. And he does that, observers say, by not being fully of either world.

The ability to apply market theory to CO2 emissions rests with the understanding that what economists previously referred to as a public good  air  is actually becoming a commodity with trading properties similar to soy beans or wheat.

That has proven true in the case of sulfur dioxide trading, and the system has also met the promise of using market incentives to improve the environment.

For the relatively low price of $750 million  the estimated cost to date to corporate America for cutting SO2 emissions  the country has reaped more than $12 billion in savings in health care costs alone, according to U.S. Environmental Protection Agency.

The companies participating in the Chicago Climate Exchange see potential benefit to their bottom lines, as well.

"We are already committed to lowering CO2 emissions by cutting our energy consumption, which will save money and benefit shareholders," says Ford's Mr. Zimmerman. "If we can figure out a low-cost way of achieving that, and if we participate in a trading program and overreduce beyond our target, we can make more money by selling our credits."

Mr. Sandor insists he is confident the CO2 market will succeed, despite its voluntary nature.

"It is reassuring to hear the naysayers' arguments for why this exchange won't work," he says. "They are the same arguments I heard for why SO2 trading wouldn't work and the same arguments for why financial futures trading wouldn't work."

But while he tries to remain a dispassionate economist, Mr. Sandor acknowledges that more than a decade of working on environmental markets has altered his perspective.

"The more I've learned, the more aware I've become of the fragility of our environment," he says. "When you see the dangers of climate change, you become passionate about solving the problem."